General Electric (NYSE:GE) naturally attracts many investors purely because of its size and diversified lines of business. For many, these two qualities are enough to convince them it is a "great company" that can be bought at nearly any price. However, Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment's merits. Here is a look at how General Electric fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor, who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using the ModernGraham method one can review a company's historical accomplishments and determine an intrinsic value that can be compared across industries.
GE data by YCharts
Defensive Investor - must pass at least 6 of the following 7 tests: Score = 6/7
- Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - current ratio greater than 2 - PASS
- Earnings Stability - positive earnings per share for at least 10 straight years - PASS
- Dividend Record - has paid a dividend for at least 10 straight years - PASS
- Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3-year averages at beginning and end of period - FAIL
- Moderate PEmg (price over normalized earnings) ratio - PEmg is less than 20 - PASS
- Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - PASS
Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - PASS
- Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - PASS
- Earnings Stability - positive earnings per share for at least 5 years - PASS
- Dividend Record - currently pays a dividend - PASS
- Earnings growth - EPSmg greater than 5 years ago - FAIL
|Value Based on 3% Growth||$20.03|
|Value Based on 0% Growth||$11.74|
|Market Implied Growth Rate||5.20%|
Balance Sheet - September 2014
Earnings Per Share
Earnings Per Share - ModernGraham
GE Dividend data by YCharts
After looking over the company's fundamentals, General Electric qualifies for both the Enterprising Investor and the even more conservative Defensive Investor. Both investor types should be concerned with the lack of earnings growth, but those concerns are not great enough on their own to turn away investors before considering the intrinsic value. As a result, all value investors should feel comfortable proceeding to the next part of the analysis, which is a determination of the company's intrinsic value.
Estimating the intrinsic value requires examining the company's earnings history. General Electric has seen its EPSmg (normalized earnings) stay relatively flat from $1.39 in 2010 to only an estimated $1.38 for 2014. This demonstrated level of earnings growth does not support the market's implied estimate of 5.2% earnings growth. This is particularly true because the company has not actually grown its earnings at all over the last few years, so there would need to be a significant change in the company's earnings in order to justify the market's current long-term estimates. As a result, our valuation model returns an estimate of intrinsic value below the market price at this time, and the company appears to be overvalued by the market.
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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.